The solutions manual for advanced financial accounting_8 pdf

Chapter 11 · Reporting financial performance 319
more pragmatic than theoretical. While the last three of these are currently the subject of
review, it is unlikely that fundamental changes will be made to existing standards. The same
might also be said of segmental reporting, which is the only topic covered in the chapter that
is not yet being actively pursued as part of the convergence programme.
The most controversial subject covered in the chapter is share-based payments. This, as
we saw, involves a number of interesting issues concerned with distinguishing between items
that should appear in the operating statements and those that would only involve move-
ments within equity. We also noted that, for many entities, the introduction of the
accounting treatment proposed in FRED 31 would have a significant impact on reported
earnings and, not surprisingly, this has generated considerable opposition. The use of share-
based payment undoubtedly has a cost which should be recognised in the financial
statements and the issue of a standard on this subject will be a true test of the ability of the
IASB to set global accounting standards in controversial areas of accounting.
Recommended reading
J. Coulton, ‘Accounting for executive stock options: a case study in avoiding tough decisions’
Australian Accounting Review, Vol. 12, No. 1, March 2002.
IATA (in association with KPMG) Segmental Reporting, Montreal, IATA, 2000.
S. Lin, ‘The association between analysts’ forecasts revisions and earning components: the evi-
dence of FRS 3’ British Accounting Review, Vol. 34, No. 1, 2002.
Excellent up-to-date and detailed reading on the subject matter of this chapter and on much of
the contents of this book is provided by the most recent edition of:
UK and International GAAP, A. Wilson, M. Davies, M. Curtis and G. Wilkinson-Riddle (eds),
Ernst & Young, Butterworths Tolley, London. At the time of writing, the latest edition is the
7th, published in 2001.
Questions
11.1 The introduction of FRS 3, Reporting Financial Performance, has resulted in a considerably
expanded profit and loss account with related disclosures and a new primary statement.
The standard is intended to be based on the ‘all-inclusive’ concept of income.
Requirements
(a) Discuss why FRS 3 was introduced and whether it has achieved its objectives.

(7 marks)
(b) Describe how the standard has implemented the ‘all-inclusive’ concept of income.
(3 marks)
ICAEW, Financial Reporting, November 1994 (10 marks)
11.2 Discuss whether the range of information provided by the implementation of FRS 3,
Reporting financial performance, is helpful to users of published financial statements.
ICAEW, Financial Reporting, May 1998 (10 marks)
320 Part 2 · Financial reporting in practice
11.3 FRS 3, Reporting financial performance, significantly supplements the financial information
required under statutory formats.
Requirements
(a) Discuss the effect of the following disclosures on users’ understanding of the finan-
cial performance of a limited company:
(i) analysis of turnover down to operating profit between continuing operations,
discontinued operations and acquisitions in the period;
(ii) statement of total recognised gains and losses; and
(iii) note of historical cost profits and losses. (13 marks)
(b) Discuss how disaggregated data required by the disclosures in SSAP 25, Segmental
reporting, assist users to analyse and interpret published financial information.
(7 marks)
ICAEW, Financial Reporting, June 2001 (20 marks)
11.4 A Ltd is a company which specialises in the processing of canned beans and canned spaghetti
for sale to retail shops. The canned beans are processed from beans bought in directly from
UK farmers. The canned spaghetti is processed from pasta which is purchased from suppliers
in Italy. Processing and canning take place at one of two factories in the United Kingdom,
one factory dealing with beans and one with spaghetti. Each factory maintains separate finan-
cial statements in order to produce a monthly operating report for Head Office.
Once canned, the products are transferred to one of four distribution centres (two cen-
tres per factory). The distribution centres (which also maintain their own individual
financial statements) are used to transfer the products to shops and supermarkets follow-

ing orders for sales. The accounting year end of the company is 31 December.
On 30 November 1995, a decision was made to rationalise the business. Due to adverse
exchange rate movements it was decided to discontinue the processing and sale of canned
spaghetti, and concentrate exclusively on canned beans. The consequence of this decision
was that the factory which processed pasta into spaghetti and one of the associated distrib-
ution centres would be sold, and the majority of the personnel employed at these locations
made redundant. It was decided to commence running down the processing operations
and the distribution operations in the factory and the distribution centre to be closed on
15 January 1996, with an expectation to complete the closure by 31 March 1996. Apart
from carrying out extensive negotiations with relevant Trades Unions regarding redun-
dancy packages, no other closure activities were to be commenced before 15 January 1996.
On 30 November 1995, A Ltd also decided to rationalise its distribution operation. The
rationalisation included closing one of the four centres (as noted above) and redefining
the areas covered by the remaining centres (so that the three remaining centres took
on the distribution formerly carried out by the four centres, with the work relating only to
baked beans). The timetable for the rationalisation of the distribution operation in the
three remaining centres was identical to that for the closure of the factory and the fourth
centre (rundown of spaghetti distribution and reallocation of beans distribution com-
mencing 15 January 1996, rationalisation complete by 31 March 1996).
You are the Chief Accountant of A Ltd, and one of the directors has recently visited you
to discuss the accounting treatment of the rationalisation. The director is unsure as to
whether the rationalisation will have any impact on the financial statements for the year
ended 31 December 1995 given that the programme did not actually commence until
15 January 1996. The director is aware that there is an accounting standard which deals
with the issue of discontinued operations but is unaware of any relevant details. The 1995
financial statements are currently in the course of preparation and are expected to be for-
mally approved by the directors at the April 1996 board meeting. For the purposes of this
question, you should assume that today’s date is 29 February 1996.
Chapter 11 · Reporting financial performance 321
Requirements

Write a memorandum for the Board of Directors which:
(a) explains how a discontinued operation is defined in FRS 3; (6 marks)
(b) outlines the accounting treatment (if any) of the decision to close the factories and
one of the distribution centres and to rationalise the operations of the remaining
distribution centres, in the financial statements of A Ltd for the year ended
31 December 1995.
Your explanation should encompass the treatment in the balance sheet and profit
and loss account and any additional information which is required in the notes to the
financial statements. (14 marks)
CIMA, Financial Reporting, May 1996 (20 marks)
11.5 Crail plc has the following matters outstanding before finalising its published financial
statements for the year ended 30 April 2002.
(1) The company sold its European business operations, excluding the fixed assets, on
10 April 2002 at a profit of £500 000. The turnover and operating profit for the year
ended 30 April 2002 relating to the European business amounted to £5 million and
£100000 respectively. The disposal of the fixed assets of the European business occurred
on 10 May 2002 when a profit of £150 000 was realised. The European operations had
been acquired in June 2001 as part of the acquisition of an unincorporated business.
(2) The company changed its accounting policy for research and development expendi-
ture from capitalisation of development expenditure under SSAP 13, Accounting for
research and development, to writing off all expenditure as incurred. As at 30 April
2002 the company had £400 000 of development expenditure capitalised with move-
ments from 30 April 2001 being:
£1000
As at 1 May 2001 250
Expenditure in year 200
Amortisation in year (50)
––––
As at 30 April 2002 400
––––

––––
The company has not yet implemented the new policy.
(3) The company revalued its land and buildings on 1 May 2001 to £5 million (land element
– £1 million). The land and buildings were bought for £3 million (land element –
£400 000) on 1 July 1997; the buildings had a total useful economic life of 50 years and
there has been no change to this following the revaluation. It is company policy to:
– charge a full year’s depreciation in the year of acquisition/revaluation;
– transfer the realised element of the revaluation reserve to realised profits annually.
The revaluation has not yet been accounted for but depreciation has been charged in
the year ended 30 April 2002 based on historic cost.
(4)
The company intends to pay an ordinary dividend of 10% of profits legally distributable.
(5) The company had a total turnover of £25 million and total operating profit of £1 mil-
lion for the year ended 30 April 2002 before any adjustments for the above items. The
company had opening balances of:
£1000
Profit and loss account 6000
Revaluation reserve –
Share capital 2000
322 Part 2 · Financial reporting in practice
(6) The taxation charge for the year ended 30 April 2002 is £350 000. No changes to this
are required as a result of the above adjustments.
Requirement
Prepare the following disclosures for the financial statements of Crail plc for the year
ended 30 April 2002:
Profit and loss account (relevant extracts only)
Statement of total recognised gains and losses
Note of historical cost profits and losses
Reconciliation of movement in shareholders’ funds
Movement on reserves disclosure note.

ICAEW, Financial Reporting, June 2002 (20 marks)
11.6 Glamis plc manufactures, distributes and retails glassware. The following matters relate to
its financial statements for the year ended 31 July 1998:
(1) On 25 June 1998, one of the company’s factories sustained damage from a freak
storm. The cost of repairs in July 1998 was £500 000 and this has been provided for in
the financial statements. The company’s insurance does not cover this repair.
(2) The company disposed of a fixed asset for £1 million in June 1998. The asset cost
£850 000 in August 1994 and had an expected life of five years. The asset was revalued
to £900 000 in the financial statements on 1 August 1996; no change to its total useful
economic life was recommended. The company does not charge depreciation in the
year of disposal of an asset and has based the profit on disposal in the profit and loss
account on the carrying value of the asset.
(3) The board of directors decided to close the company’s retailing division on the basis of
a formal plan submitted by the sales director. The company had accepted a firm offer
of £3 million for the retail premises by 31 July 1998. The net book value of the
premises was £2 million. Half of the staff involved in the retailing division were made
redundant by 31 July 1998 at a cost of £500 000; the remaining staff were redeployed
and retrained at a cost of £200 000. All these transactions have been included in the
financial statements.
(4) The directors decided to change the accounting treatment of development costs to
immediate write-off against profit as costs are incurred. This change has not yet been
reflected in the draft financial statements. The balance on the development costs
account at 31 July 1998 was £250000 of which £200000 was incurred by 31 July 1997.
The company’s draft summarised profit and loss account shows:
£000
Turnover 5500
Cost of sales (3100)
–––––
Gross profit 2400
Distribution costs (1100)

Administrative expenses (500)
––––
Profit before taxation 800
Taxation (240)
––––
Profit after taxation 560
Dividends (100)
––––
460
––––
––––
Chapter 11 · Reporting financial performance 323
Opening shareholders’ funds as on 1 August 1997 were £1.2 million, as previously
reported.
Requirements
(a) Advise the board of directors of Glamis plc on the most appropriate accounting treat-
ment and disclosure for each of the above matters, preparing all necessary
calculations. You should refer to relevant accounting standards and legislation as
appropriate. (10 marks)
Note: You are not required to prepare extracts of the financial statements.
(b) Prepare the following extracts of the financial statements for Glamis plc:
(i) Statement of total recognised gains and losses
(ii) Note of historical cost profit and losses
(iii) Reconciliation of movements on shareholders’ funds. (9 marks)
Note: You should provide comparative figures as far as you can from the information
available.
ICAEW, Financial Reporting, September 1998 (19 marks)
11.7 The Accounting Standards Board has published a Discussion Paper, Reporting Financial
Performance: Proposals for Change. The proposals in the Discussion Paper build upon the
strengths of, and are a progression from FRS 3, Reporting Financial Performance. It pro-

poses that a single performance statement should replace the profit and loss account and
the Statement of Total Recognised Gains and Losses, effectively combining them in one
statement. The paper also takes the view that gains and losses should be reported only once
and in the period when they arise, and should not be reported again in another component
of the financial statements at a later date, a practice which is sometimes called ‘recycling’.
Required:
(a) (i) Explain the reasons for presenting financial performance in one statement rather
than two or more statements; (8 marks)
(ii) Discuss the views for and against the recycling of gains and losses in the financial
statements. (6 marks)
(b) Describe how the following items are dealt with under current Financial Reporting
Standards, and how their treatment would change if the Discussion Paper were
adopted:
(i) Gains and losses on the disposal of fixed assets; (4 marks)
(ii) Revaluation gains and losses on fixed assets; (4 marks)
(ii) Foreign currency translation adjustments arising on the net investment in for-
eign operations. (3 marks)
ACCA, Financial Reporting Environment (UK Stream), December 2000 (25 marks)
11.8 Travis plc is a large grocery retailing and wholesaling organisation. It is presently drawing
up its financial statements for the year ended 31 October 1993 and, mindful of the require-
ments of SSAP 25, has drafted the following segmental report:
324 Part 2 · Financial reporting in practice
Segment information
Turnover Profit before tax Operating net assets
31.10.93 31.10.92 31.10.93 31.10.92 31.10.93 31.10.92
£m £m £m £m £m £m
By category
Retailing
Food 5650 6126 300 295 2925 2964
Drinks 1951 2047 219 136 987 917

Consumables 115 106 8 5 86 82
Wholesaling
Warehousing 3 843 3 651 391 382 1560 1490
–––––– –––––– –––– –––– ––––– –––––
11559 11930 918 818 5 558 5 453
–––––– –––––– –––– –––– ––––– –––––
By activity
Retailing
Hypermarkets 6235 6608 465 314 3 120 3 040
Large shops 545 534 43 40 560 538
Small shops 936 1137 19 82 318 385
Wholesaling
Warehousing 3 843 3 651 391 382 1560 1490
–––––– –––––– –––– –––– ––––– –––––
11559 11930 918 818 5558 5 453
–––––– –––––– –––– –––– ––––– –––––
Notes
Head office and service costs of £53 million (1992: £51 million) have been allocated according to the relative
contribution of each segment to the total of continuing operations.
The group’s borrowing requirements are centrally managed and so interest expense of £475 million
(1992: £415 million) has been apportioned on the basis of average net assets for each segment.
Operating net assets represent the group’s net assets adjusted to exclude interest bearing operating assets
and liabilities.
Businesses discontinued during the year contributed £450 million (1992: £850 million) to turnover and
£38 million (1992: £68 million) to profit before tax.
Requirements
(a) Discuss the objectives of segmental reporting in the context of each of the following
user groups of financial statements:
(i) the shareholder group
(ii) the investment analyst group

(iii) the lender/creditor group
(iv) Government. (10 marks)
(b) Critically assess the presentation of Travis plc’s draft ‘Segment information’ report,
considering in particular its helpfulness to users of financial statements and its com-
pliance with the requirements of SSAP 25. Outline any ways in which the information
might be presented more effectively or in which the treatment of items might be
improved. (11 marks)
ICAEW, Financial Accounting 2, December 1993 (21 marks)
11.9 Spreader plc is a UK parent company with a number of wholly-owned subsidiaries in the
USA and Europe. Extracts from the consolidated financial statements of the group for the
year ended 30 April 1997 are given below.
Chapter 11 · Reporting financial performance 325
Profit and loss account – year ended 30 April 1997 1996
£000 £000
Turnover (Note 1) 50000 48000
Cost of sales (25000) (22000)
––––––– –––––––
Gross profit 25000 26 000
Other operating expenditure (15000) (14200)
––––––– –––––––
Operating profit 10000 11 800
Interest payable (1000) (900)
––––––– –––––––
Profit before taxation (Note 2) 9000 10900
Taxation (2800) (3600)
––––––– –––––––
Profit after taxation 6200 7 300
Dividend (3000) (3200)
––––––– –––––––
Retained profit 3200 4 100

––––––– –––––––
Note 1 Analysis of turnover for the year by geographical segment
UK US Rest of Europe Total
1997 1996 1997 1996 1997 1996 1997 1996
£000 £000 £000 £000 £000 £000 £000 £000
Total sales 15000 20000 10000 8 000 30000 25000 55000 53 000
Inter-segment sales (2000) (2500) (1 000) (500) (2000) (2000) (5000) (5000)
–––––– –––––– –––––– ––––– –––––– –––––– –––––– ––––––
Sales to third parties 13000 17500 9 000 7 500 28000 23000 50000 48000
–––––– –––––– –––––– ––––– –––––– –––––– –––––– ––––––
Note 2 Analysis of profit before tax for the year by geographical segment
UK US Rest of Europe Total
1997 1996 1997 1996 1997 1996 1997 1996
£000 £000 £000 £000 £000 £000 £000 £000
Segment profit 3 000 6000 1500 1200 6000 5000 10500 12200
Common costs (500) (400)
–––––– ––––––
Operating profit 10000 11800
Interest payable (1000) (900)
–––––– ––––––
Profit before taxation 9000 10900
–––––– ––––––
Note 3 Analysis of net assets at end of year by geographical segment
UK US Rest of Europe Total
1997 1996 1997 1996 1997 1996 1997 1996
£000 £000 £000 £000 £000 £000 £000 £000
Segment net assets 15000 13500 6000 5000 20000 20000 41000 38500
Unallocated assets 2000 1800
–––––– ––––––
Total net assets 43000 40300

–––––– ––––––
Requirements
In your capacity as chief accountant of Spreader plc,
(a) prepare a report for the board of directors of the company which analyses the results of the
group for the year ended 30 April 1997; (21 marks)
(b) explain why the segmental data which has been included in the extracts may need to be inter-
preted with caution. (4 marks)
CIMA, Financial Reporting, May 1997 (25 marks)
326 Part 2 · Financial reporting in practice
11.10 (a) For enterprises that are engaged in different businesses with differing risks and
opportunities, the usefulness of financial information concerning these enterprises is
greatly enhanced if it is supplemented by information on individual business seg-
ments. It is recognised that there are two main approaches to segmental reporting.
The risk and returns’ approach where segments are identified on the basis of differ-
ent ‘risks and returns arising from different lines of business and geographical areas,
and the ‘managerial’ approach whereby segments are identified corresponding to the
enterprises’ internal organisation structure.
Required
(i) Explain why the information content of financial statements is improved by the
inclusion of segmental data on individual business segments. (5 marks)
(ii) Discuss the advantages and disadvantages of analysing segmental data using the
‘risk and returns’ approach (4 marks)
the ‘managerial’ approach. (3 marks)
(b) AZ, a public limited company, operates in the global marketplace.
(i) The major revenue-earning asset is a fleet of aircraft which are registered in the
UK and its other main source of revenue comes from the sale of holidays. The
directors are unsure as to how business segments are identified. (3 marks)
(ii) The company also owns a small aircraft manufacturing plant which supplies air-
craft to its domestic airline and to third parties. The preferred method for
determining transfer prices for these aircraft between the group companies is

market price, but where the aircraft is of a specialised nature with no equivalent
market price the companies fix the price by negotiation. (2 marks)
(iii) The company has incurred an exceptional loss on the sale of several aircraft to a
foreign government. This loss occurred due to a fixed price contract signed sev-
eral years ago for the sale of secondhand aircraft and resulted through the
fluctuation of the exchange rates between the two countries. (3 marks)
(iv) During the year the company discontinued its holiday business due to competi-
tion in the sector. (2 marks)
(v) The company owns 40% of the ordinary shares of Eurocat Ltd, a specialist air-
craft engine producer with operations in China and Russia. The investment is
accounted for by the equity method and it is proposed to exclude the company’s
results from segment assets and revenue. (3 marks)
Required
Discuss the implications of each of the above points for the determination of the seg-
mental information required to be prepared and disclosed under SSAP 25 Segmental
Reporting and FRS 3 Reporting Financial Performance.
Please note that the mark allocation is shown after each paragraph in part (b).
ACCA, Financial Reporting Environment (UK Stream), June 1999 (25 marks)
11.11 You are the Management Accountant of Global plc. Global plc has operations in a
number of different areas of the world and presents segmental information on a geo-
graphical basis in accordance with SSAP 25 Segmental reporting. The segmental
information for the year ended 30 June 2002 is given below:
Chapter 11 · Reporting financial performance 327
Europe America Africa Group
2002 2001 2002 2001 2002 2001 2002 2001
£m £m £m £m £m £m £m £m
TURNOVER
Turnover by destination:
Sales to third parties 700 680 600 550 400 200 1700 1430
–––– –––– –––– –––– –––– –––– ––––– –––––

–––– –––– –––– –––– –––– –––– ––––– –––––
Turnover by origin:
Total sales 720 685 610 560 440 205 1770 1450
Inter-segment sales (20) (5) (10) (10) (40) (5) (70) (20)
–––– –––– –––– –––– –––– –––– ––––– –––––
Sales to third parties 700 680 600 550 400 200 1700 1430
–––– –––– –––– –––– –––– –––– ––––– –––––
–––– –––– –––– –––– –––– –––– ––––– –––––
PROFIT BEFORE
TAXATION
Segment profit 1 (loss) 70 69 990 90 (20) (40) 140 119
––– ––– –––– ––– ––– –––
––– ––– –––– ––– ––– –––
Common costs (25) (20)
––– –––
Operating profit 115 99
Net interest (18) (15)
––– –––
97 84
Group share of associates’
profit before taxation 10 9 12 5 – – 22 14
––– –– ––– –– –– –– –––– –––
––– –– ––– –– –– ––
Group profit before taxation 119 98
–––– –––
–––– –––
NET ASSETS
Segment net assets 350 320 360 330 200 180 910 830
–––– –––– –––– –––– –––– ––––
–––– –––– –––– –––– –––– ––––

Unallocated assets 120 100
––––– ––––
1030 930
Group share of net assets of
associates 55 52 36 30 – – 91 82
––– ––– ––– ––– ––– ––– ––––– –––––
––– ––– ––– ––– ––– –––
Total net assets 1121 1012
––––– –––––
––––– –––––
Your Managing Director has reviewed the segmental information above and has
expressed concerns about the performance of Global plc. He is particularly concerned
about the fact that the Africa segment has been making losses ever since the initial invest-
ment in 2000. He wonders whether operations in Africa should be discontinued, given
the consistently poor results.
Required
Prepare a report for the Managing Director of Global plc that analyses the performance
of the three geographical segments of the business, based on the data that has been pro-
vided. The report can take any form you wish, but you should specifically refer to any
reservations you may have regarding the use of the segmental data for analysis purposes.
CIMA, Financial Reporting – UK Accounting Standards, November 2002 (20 marks)
328 Part 2 · Financial reporting in practice
11.12 FRS 3, Reporting Financial Performance, requires that earnings per share should be calcu-
lated on the profit after tax, minority interest and extraordinary items. FRS 3 permits an
additional measure of earnings per share to be disclosed provided it is presented on a
consistent basis over time and reconciled to the amount required by the standard. There
should also be an explanation of the reasons for calculating the additional version.
As a result, there is no longer a unique measure of performance. Is this a good thing and
what problems might this give preparers and users of financial statements?
ICAEW, Financial Accounting 2, July 1994 (12 marks)

11.13 A plc is a company which is listed on the UK Stock Exchange. Your client, Mr B, cur-
rently owns 300 shares in A plc. Mr B has recently received the published financial
statements of A plc for the year ended 30 September 1998. Extracts from these published
financial statements, and other relevant information, are given below. Mr B is confused
by the statements. He is unsure how the performance of the company during the year
will affect the market value of his shares, but is aware that the published earnings per
share (EPS) is a statistic which is often used by analysts in assessing the performance of
listed companies.
Profit and loss accounts – year ended 30 September
1998 1997
£ million £ million
Turnover 10 000 8500
Cost of sales (6300) (5100)
–––––– ––––––
Gross profit 3700 3400
Other operating expenses (1900) (1800)
–––––– ––––––
Operating profit 1 800 1600
Interest payable (300) (320)
–––––– ––––––
Profit before taxation 1500 1280
Taxation (470) (400)
–––––– ––––––
Profit after taxation 1030 880
Equity dividend (800) (500)
–––––– ––––––
Retained profit 230 380
–––––– ––––––
–––––– ––––––
Balance sheets at 30 September

1998 1997
£ million £ million £ million £ million
Fixed assets
Intangible assets 3000 –
Tangible assets 4000 3700
––––– –––––
7000 3700
Current assets
Stocks 1300 1000
Debtors 1500 1200
Cash in hand and at bank 100 90
––––– –––––
2900 2290
––––– –––––
Chapter 11 · Reporting financial performance 329
1998 1997
£ million £ million £ million £ million
Current liabilities
Trade creditors 900 700
Taxation 500 420
Proposed dividend 800 500
Bank overdraft 600 700
––––– –––––
2800 2320
––––– –––––
Net current assets 100 (30)
––––– –––––
Total assets less current liabilities 7100 3670
Creditors: amounts falling due
after more than one year:

Loan stock (2000) (2 000)
––––– –––––
5100 1670
––––– –––––
––––– –––––
Capital and reserves
Called-up share capital 1500 500
Share premium account 2700 500
Profit and loss account 900 670
––––– –––––
5100 1670
––––– –––––
––––– –––––
Information regarding share capital
The called-up share capital of the company comprises £1 equity shares only. On 1 April
1998, the company made a rights issue to existing shareholders of two new shares for
every one share held, at a price of £3.30 per share, paying issue costs of £100 000. The
market price of the shares immediately before the rights issue was £3.50 per share. No
changes took place in the equity capital of A plc in the year ended 30 September 1997.
Requirements
(a) Compute the EPS figures (current year plus comparative) that will be included in
the published financial statements of A plc for the year ended 30 September 1998.
(5 marks)
(b) Using the extracts with which you have been provided, write a short report to Mr B
which identifies the key factors which have led to the change in the EPS of A plc
since the year ended 30 September 1997. (10 marks)
(c) Comment on the relevance of the EPS statistic to a shareholder like Mr B who is
concerned about the market value of his shares. (5 marks)
CIMA, Financial Reporting, November 1998 (20 marks)
11.14 Earnings per share is one of the most quoted statistics in financial analysis, coming into

prominence because of the widespread use of the price earnings ratio as an investment
decision making yardstick. In 1972 SSAP 3 Earnings per share, was issued and revised in
1974, and the standard as amended was operating reasonably effectively. In fact the
Accounting Standards Board (ASB) has stated that a review of earnings per share would
not normally have been given priority at this stage of the Board’s programme. However,
in June 1997 FRED 16 Earnings per share, was issued which proposed amendments to
SSAP 3 and subsequently in October 1998 FRS 14 Earnings per share was published.
330 Part 2 · Financial reporting in practice
Required
(a) (i) Describe the main changes to SSAP 3 which have occurred as a result of FRS 14
and the main reasons for those changes. (6 marks)
(ii) Explain why there is a need to disclose diluted earnings per share in financial
statements. (5 marks)
(b) The following financial statement extracts for the year ending 31 May 1999 relate to
Mayes, a public limited company.
£000 £000
Operating profit
Continuing operations 26700
Discontinued operations (1120)
––––––
25580
Continuing operations
Profit on disposal of tangible fixed assets 2500
Discontinued operations
(Loss) on sale of operations (5080)
––––––
23000
Interest payable (2100)
––––––
Profit on ordinary activities before taxation 20900

Tax on profit on ordinary activities (7500)
––––––
Profit on ordinary activities after tax 13400
Minority interest – equity (540)
––––––
Profit attributable to members of parent company 12860
Dividends:
Preference dividend on non-equity shares 210
Ordinary dividend on equity shares 300
––––
(510)
Other appropriations – non-equity shares (note iii) (80)
––––––
Retained profit for year 12270
––––––
Capital as at 31 May 1999. £000
Allotted, called up and fully paid ordinary shares of £1 each 12500
7% convertible cumulative redeemable preference shares of £1 3000
––––––
15500
––––––
Additional Information
(i) On 1 January 1999, 3.6 million ordinary shares were issued at £2.50 in consideration
of the acquisition of June Ltd for £9 million. These shares do not rank for dividend
in the current period. Additionally the company purchased and cancelled £24 mil-
lion of its own £1 ordinary shares on 1 April 1999. On 1 July 1999, the company
made a bonus issue of 1 for 5 ordinary shares before the financial statements were
issued for the year ended 31 May 1999.
(ii) The company has a share option scheme under which certain directors can subscribe
for the company’s shares. The following details relate to the scheme.

Chapter 11 · Reporting financial performance 331
Options outstanding 31 May 1998:
(i) 1.2 million ordinary shares at £2 each
(ii) 2 million ordinary shares at £3 each
both sets of options are exercisable before 31 May 2000.
Options granted during year 31 May 1999
(i) One million ordinary shares at £4 each exercisable before 31 May 2002, granted
1 June 1998.
During the year to 31 May 1999, the options relating to the 1.2 million ordinary
shares (at a price of £2) were exercised on 1 March 1999.
The average fair value of one ordinary share during the year was £5.
(iii) The 7% convertible cumulative redeemable preference shares are convertible at the
option of the shareholder or the company on 1 July 2000, 2001, 2002 on the basis of
two ordinary shares for every three preference shares. The preference share dividends
are not in arrears. The shares are redeemable at the option of the shareholder on
1 July 2000, 2001, 2002 at £1.50 per share. The ‘other appropriations – non-equity
shares’ item charged against the profits relates to the amortisation of the redemption
premium and issue costs on the preference shares.
(iv) Mayes issued £6 million of 6% convertible bonds on 1 June 1998 to finance the
acquisition of Space Ltd. Each bond is convertible into 2 ordinary shares of £1.
Assume a corporation tax rate of 35%.
(v) The interest payable relates entirely to continuing operations and the taxation charge
relating to discontinued operations is assessed at £100 000 despite the accounting
losses. The loss on discontinued operations relating to the minority interest
is £600000.
Requirement
Calculate the basic and diluted earnings per share for the year ended 31 May 1999 for
Mayes plc utilising FRS 14 Earnings per share. (14 marks)
(Candidates should show a calculation of whether potential ordinary shares are dilutive
or anti-dilutive.)

ACCA, Financial Reporting Environment (UK Stream), June 1999 (25 marks)
11.15 Earnit plc is a listed company. The issued share capital of the company at 1 April 1999
was as follows:
● 500 million equity shares of 50p each.
● 100 million £1 non-equity shares, redeemable at a premium on 31 March 2004. The
effective finance cost of these shares for Earnit plc is 10% per annum. The carrying
value of the non-equity shares in the financial statements at 31 March 1999 was £110
million.
Extracts from the consolidated profit and loss account of Earnit plc for the year ended
31 March 2000 showed:
332 Part 2 · Financial reporting in practice
£ million
Turnover 250
Cost of sales (130)
––––
Gross profit 120
Other operating expenses (40)
––––
Operating profit 80
Exceptional gain 10
Interest payable (25)
––––
Profit before taxation 65
Taxation (20)
––––
Profit after taxation 45
Appropriations of profit (see note) (26)
––––
Retained profit 19
––––

––––
Note – appropriations of profit:
● to non-equity shareholders 11
● to equity shareholders 15
––––
26
––––
––––
The company has a share option scheme in operation. The terms of the option are that
option holders are permitted to purchase 1 equity share for every option held at a price of
£1.50 per share. At 1 April 1999, 100 million share options were in issue. On 1 October
1999, the holders of 50 million options exercised their option to purchase, and 70 million
new options were issued on the same terms as the existing options. During the year ended
31 March 2000, the average market price of an equity share in Earnit plc was £2.00.
There were no changes to the number of shares or share options outstanding during
the year ended 31 March 2000 other than as noted in the previous paragraph.
Requirements
(a) Compute the basic and diluted earnings per share of Earnit plc for the year ended
31 March 2000. Comparative figures are NOT required. (10 marks)
(b) Explain to a holder of equity shares in Earnit plc the usefulness of both of the fig-
ures you have calculated in part (a). (10 marks)
CIMA, Financial Reporting, May 2000 (20 marks)
11.16 (a) The Accounting Standards Board (ASB) believes that undue emphasis is placed on
Earnings per share (EPS) and that this leads to simplistic interpretation of financial
performance. Many chief executives believe that their share price does not reflect the
value of their company and yet are pre-occupied with earnings based ratios. It
appears that if chief executives shared the views of the ASB then they may disclose
more meaningful information than EPS to the market, which may then reduce the
reporting gap and lead to higher share valuations. The ‘reporting gap’ can be said to
be the difference between the information required by the stock market in order to

evaluate the performance of a company and the actual information disclosed.
Required
(i) Discuss the potential problems of placing undue emphasis on the Earnings per
share figure. (5 marks)
Chapter 11 · Reporting financial performance 333
(ii) Discuss the nature of the ‘reporting gap’ and how the ‘gap’ might be eliminated.
(5 marks)
(b) Company X has a complex capital structure. The following information relates to the
company for the year ending 31 May 2001:
(i) The net profit of the company for the period attributable to the preference and
ordinary shareholders of the parent company was £14.6 million. Of this amount
the net profit attributable to discontinued operations was £3.3 million.
The following details relate to the capital of the company:
million
(ii) Ordinary shares of £1 in issue at 1 June 2000 6.0
Ordinary shares of £1 issued 1 September 2000 1.2
at full market price.
The average market price of the shares for the year ending 31 May 2001 was
£10 and the closing market price of the shares on 31 May 2001 was £11. On
1 January 2001, 300000 partly paid ordinary shares of £1 were issued. They were
issued at £8 per share with £4 payable on 1 January 2001 and £4 payable on
1 January 2002. Dividend participation was 50 per cent until fully paid.
(iii) Convertible loan stock of £20 million at an interest rate of 5% per annum was
issued at par on 1 April 2000. Half a year’s interest is payable on 30 September
and 31 March each year. Each £1000 of loan stock is convertible at the holder’s
option into 30 ordinary shares at any time. £5 million of loan stock was con-
verted on 1 April 2001 when the market price of the shares was £34 per share.
(iv) £1 million of convertible preference shares of £1 were issued in the year to
31 May 1998. Dividends are paid half yearly on 30 November and 31 May at a
rate of 6% per annum. The preference shares are convertible into ordinary

shares at the option of the preference shareholder on the basis of two preference
shares for each ordinary share issued. Holders of 600 000 preference shares con-
verted them into ordinary shares on 1 December 2000.
(v) Warrants to buy 600 000 ordinary shares at £6.60 per share were issued on
1 January 2001. The warrants expire in five years’ time. All the warrants were
exercised on 30 June 2001. The financial statements were approved on 1 August
2001.
(vi) The rate of taxation is to be taken as 30%.
Required
Calculate the basic and diluted Earnings per share for X for the year ended 31 May
2001 in accordance with FRS 14 Earnings per share. (15 marks)
ACCA, Financial Reporting Environment (UK Stream), June 2001 (25 marks)
11.17 Related party relationships and transactions are a normal feature of business. Enterprises
often carry on their business activities through subsidiaries and associates and it is
inevitable that transactions will occur between group companies. Until relatively recently
the disclosure of related party relationships and transactions has been regarded as an area
which has a relatively low priority. However, recent financial scandals have emphasised
the importance of an accounting standard in this area.
334 Part 2 · Financial reporting in practice
Required
(a) (i) Explain why the disclosure of related party relationships and transactions is an
important issue. (6 marks)
(ii) Discuss the view that small companies should be exempt from the disclosure of
related party relationships and transactions on the grounds of their size.
(4 marks)
(b) Discuss whether the following events would require disclosure in the financial state-
ments of the RP Group plc under FRS 8 Related Party Disclosures.
RP Group plc, merchant bankers, has a number of subsidiaries, associates and joint
ventures in its group structure. During the financial year to 31 October 1999, the fol-
lowing events occurred:

(i) The company agreed to finance a management buyout of a group company, AB,
a limited company. In addition to providing loan finance, the company has
retained a twenty-five per cent equity holding in the company and has a main
board director on the board of AB. RP received management fees, interest pay-
ments and dividends from AB. (6 marks)
(ii) On 1 July 1999, RP sold a wholly owned subsidiary, X a limited company, to Z, a
public limited company. During the year RP supplied X with second-hand office
equipment and X leased its factory from RP. The transactions were all con-
tracted for at market rates. (4 marks)
(iii) The pension scheme of the group is managed by another merchant bank. An
investment manager of the group pension scheme is also a non-executive direc-
tor of the RP Group and received an annual fee for his services of £25 000 which
is not material in the group context. The company pays £16m per annum into
the scheme and occasionally transfers assets into the scheme. In 1999, fixed
assets of £10m were transferred into the scheme and a recharge of administrative
costs of £3m was made. (5 marks)
ACCA, Financial Reporting Environment (UK Stream), December 1999 (25 marks)
11.18 (a) Explain the purpose of FRS 8, Related party disclosures, its relevance to users of
published financial information and the main differences to international account-
ing standards. (6 marks)
(b) The directors of Sidlaw Ltd have requested your advice on the appropriate account-
ing disclosures for the following:
(1) On 1 February 2001, Sidlaw Ltd purchased 75% of the ordinary share capital of
Errol Ltd. Sidlaw Ltd sells £250000 worth of goods to Errol Ltd every month and
has done so for many years.
(2) Sidlaw Ltd has a self-managed pension fund for its employees and pays £4 mil-
lion per annum into the fund. Sidlaw Ltd’s directors also act as fund managers
for which Sidlaw Ltd makes no charge to the pension fund.
(3) Mr Muir owns and controls Sidlaw Ltd and Kirric Ltd and has influence, but not
control, over Glamis Ltd. All three companies buy and sell goods to each other

but are not part of the same group.
Requirement
Advise the directors of Sidlaw Ltd on the appropriate accounting disclosures
required under FRS 8, Related party disclosures, for all affected companies, provid-
ing brief reasons for your recommendations. (7 marks)
ICAEW, Financial Reporting, June 2001 (13 marks)
Chapter 11 · Reporting financial performance 335
11.19
Newcars plc is a vehicle dealership; it sells both new and good quality second-hand cars. The
company is large and has a large number of shareholders. The only large block of shares is
held by Arthur, who owns 25% of Newcars plc. Arthur is a member of Newcars plc’s board of
directors and he takes a keen interest in the day-to-day management of the company.
Arthur also owns 25% of Oldcars plc. Oldcars plc sells inexpensive second-hand cars
which tend to be either relatively old or have a high mileage. Arthur is also a member of
the board of directors of Oldcars plc.
Apart from Arthur, Newcars plc and Oldcars plc have no shareholders in common.
The only thing that they have in common, apart from Arthur’s interest in each, is that
Newcars plc sells a large number of cars to Oldcars plc. This usually happens when a cus-
tomer of Newcars plc has traded in a car that is too old to be sold from Newcars plc’s
showroom. Most of these cars are immediately resold to Oldcars plc and go into Oldcars
plc’s normal trading stock. These sales account for approximately 5% of Newcars plc’s
turnover. Oldcars plc acquires approximately 20% of its cars from Newcars plc.
Required
(a) Explain whether Newcars plc and Oldcars plc are related parties in terms of the
requirements of FRS 8, Related party disclosures. List any additional information
that you would require before making a final decision. (7 marks)
(b) Assuming that Newcars plc and Oldcars plc are related parties, describe the related
parties’ disclosures that would have to be made in the companies’ financial state-
ments in respect of the sale and purchase of cars between the two companies.
(6 marks)

(c) Explain why it is necessary to disclose such information in respect of transactions
involving related parties. (7 marks)
CIMA, Financial Accounting – UK Accounting Standards, May 2001 (20 marks)
11.20 Engina, a foreign company, has approached a partner in your firm to assist in obtaining a
Stock Exchange listing for the company. Engina is registered in a country where transac-
tions between related parties are considered to be normal but where such transactions are
not disclosed. The directors of Engina are reluctant to disclose the nature of their related
party transactions as they feel that although they are a normal feature of business in their
part of the world, it could cause significant problems politically and culturally to disclose
such transactions.
The partner in your firm has requested a list of all transactions with parties connected
with the company and the directors of Engina have produced the following summary:
(a) Every month, Engina sells £50 000 of goods per month to Mr Satay, the financial
director. The financial director has set up a small retailing business for his son and
the goods are purchased at cost price for him. The annual turnover of Engina is £300
million. Additionally Mr Satay has purchased his company car from the company for
£45 000 (market value £80 000). The director, Mr Satay, owns directly 10% of the
shares in the company and earns a salary of £500 000 a year, and has a personal for-
tune of many millions of pounds.
(b) A hotel property had been sold to a brother of Mr Soy, the Managing Director of
Engina, for £4 million (net of selling cost of £0.2 million). The market value of the
property was £4.3 million but in the overseas country, property prices were falling
rapidly. The carrying value of the hotel was £5 million and its value in use was £3.6
million. There was an over supply of hotel accommodation due to government sub-
sidies in an attempt to encourage hotel development and the tourist industry.
336 Part 2 · Financial reporting in practice
(c) Mr Satay owns several companies and the structure of the group is as follows:
Engina earns 60% of its profit from transactions with Car and 40% of its profit from
transactions with Wheel.
Required

Write a report to the directors of Engina setting out the reasons why it is important to
disclose related party transactions and the nature of any disclosure required for the above
transactions under the UK regulatory system before a Stock Exchange quotation can be
obtained. (25 marks)
The mark allocation will be as follows:
Marks
Style/layout of report 4
Reasons 8
Transaction (a) 4
(b) 5
(c) 4
–––
25
–––
ACCA, Advanced Corporate Reporting, Pilot Paper (2002)
100% ownership
of Car Limited
Mr Satay
80% ownership
of Wheel Limited
90% ownership
of Engina Limited
Ta xation: current and deferred
chapter
12
In this chapter we look briefly at the treatment of current taxation and then, in more depth,
at the subject of accounting for deferred taxation. While the former is concerned mainly with
the presentation of corporation tax, income tax and overseas taxes in financial statements,
the subject of deferred taxation poses a number of conceptual problems and is conse-
quently both more difficult to understand and more controversial.

The main issues associated with current taxation concern the presentation of the current
tax charge in the financial statements and the treatment of tax credits and withholding
taxes. These are addressed in FRS16 Current Taxes, and, in a broadly similar way, in IAS 12
Income Taxes.
In the case of deferred taxation, the issues are whether to account for it at all and, if so, in
what way. We look first at the perceived need to account for deferred taxation based on the
view that taxation is an expense subject to the accruals or matching concept. The argument
is that, if there are timing differences, that is differences between the periods in which rev-
enues and expenses are recognised in the financial statements and the periods in which
they are included when calculating the tax liability, then the tax expense shown in the finan-
cial statements should be the notional tax charge based on the revenues and expenses
included in the financial statements rather than the tax payable in respect of the period.
We explain that, although SSAP 15 required partial provision for deferred taxation,
FRS 19 Deferred Taxation, has now brought UK practice closer to the international standard
IAS 12 Income Taxes, by requiring full provision for deferred tax using a liability method.
However, we also examine the substantial differences between the UK and international
standards, which will pose considerable difficulties in the attempt to achieve convergence,
and cast serious doubt upon whether either method can really be called a full provision
method at all.
In this chapter, we draw upon the following UK and international standards:
● SSAP 5 Accounting for Value Added Tax (1974)
● FRS 16 Current Tax (1999)
● FRS 19 Deferred Tax (2000)
● IAS 12 Income Taxes (revised 2000)
Introduction
The treatment of taxation in financial statements in the UK is regulated not only by the
Companies Acts but also by three standards: SSAP 5 Accounting for Value Added Tax (April
1974), FRS 16 Current Tax (December 1999) and FRS 19 Deferred Tax (December 2000).
The relevant international standard is IAS12 Income Taxes (revised October 2000).
SSAP 5 is probably the shortest and simplest standard one is likely to see. Its message is

that Value Added Tax (VAT) should not be included in turnover nor included in expenses
overview
338 Part 2 · Financial reporting in practice
or as part of the cost of an asset except where the tax is irrecoverable. In other words, the
VAT collected from customers on behalf of the government and the VAT paid on inputs do
not appear in the financial statements, except to the extent that the balance due to or from
the government is shown as a liability or asset respectively. While there are, from time to
time, interesting legal disputes about which transactions are subject to VAT, these do not
generally touch upon financial accounting concepts and we will not pursue the subject of
Value Added Tax any further in this book.
In this chapter, we first deal with the treatment of current taxation, where the issues relate
mainly to presentation. FRS 16 sets out standard accounting practice on how current tax should
be reflected in financial statements and is especially concerned with the treatment of tax credits
and withholding taxes. Its requirements are broadly consistent with the international standard
IAS 12 Income Taxes, although, as we shall see later, there are some minor differences.
The main part of the chapter is devoted to deferred taxation, an area in which standard set-
ters have found it extremely difficult to follow a consistent path. Deferred taxation becomes
relevant when there are different rules for the treatment of income and expenses in financial
statements and tax computations. Some differences may be permanent: a good example is busi-
ness entertainment expenses where an expense properly charged in a profit and loss account
has not been allowed as a tax expense in the UK for the past forty years or so. Permanent dif-
ferences do not give rise to deferred taxation: the expense is not allowable for tax purposes, the
taxable profit is higher than the accounting profit, and that is the end of the matter.
The perceived need to account for deferred taxation arises when there are timing differ-
ences, that is when the same revenue or expense is recognised in different periods in financial
statements and tax computations. Where the timing difference reverses in the following
period, there would be widespread agreement that it is necessary to account for deferred tax-
ation. However, as we shall see, not all timing differences reverse so quickly. In some cases,
the reversal of the timing difference may be remote, encouraging arguments that it should
therefore be ignored. The previous accounting standard, SSAP 15 Accounting for Deferred

Tax, went even further than this by taking the view that a provision for deferred tax was
unnecessary where a timing difference expected to reverse in future would itself be replaced
by a new originating timing difference in that same future period!
A deferred tax approach that takes account of all timing differences is known as full provi-
sion while one which takes into account only those timing differences which are expected to
reverse in the foreseeable future is known as partial provision. As we shall see, even the so-
called full provision methods required by current UK and international standards require
important, although different, exclusions.
As with several other topics, relevant UK standards on this subject have not been consis-
tent. The first standard, SSAP 11 Accounting for Deferred Taxation, published in 1975,
required full provision for deferred taxation but the weight of opposition was such that this
standard was withdrawn before its effective date. UK accountants had to wait until 1978 for
SSAP 15, a standard that required the use of the partial provision approach. This partial pro-
vision method was very much a practical response to a set of circumstances existing in the
late 1970s and early 1980s but, to cut a long story short, it had serious conceptual weak-
nesses, was open to manipulation by directors and is now completely out of line with
international practice. Following earlier publications,
1
the ASB issued FRS 19 Deferred Tax in
December 2000.
1
The ASB issued a Discussion Paper Accounting for Tax (March 1995), which dealt with both current taxation and
deferred taxation. It subsequently issued an exposure draft of a ‘Proposed Amendment to SSAP 8: Presentation of
Dividend Income’ (October 1997). More recently it has dealt with current taxation and deferred taxation sep-
arately by the issue of FRED 18 Current Taxation (June 1999) and FRED 19 Deferred Taxation (August 1999).
Chapter 12 · Taxation: current and deferred 339
FRS 19 requires full provision for deferred taxation on timing differences, using what is
described as the incremental liability approach but, as we shall see, it exempts certain major
timing differences and hence its requirements still fall rather short of full provision.
In the section of the chapter dealing with deferred taxation we explain timing differences

and the perceived need for deferred taxation. We then examine the different approaches
which could be adopted before we turn to the proposals of FRS 19 and IAS 12 respectively.
Current taxation
Readers are assumed to be aware of the law relating to the taxation of companies and we
shall only refer to the system to the extent necessary to provide an understanding of the
accounting implications of that system. For simplicity, we shall assume that a company
makes up its financial statements for a year, rather than any other period, and that the rate of
corporation tax is 30 per cent, the rate applicable to companies with chargeable profits in
excess of £1500 000.
2
Corporation tax
The corporation tax of small companies is due in one amount payable nine months and one
day after the end of its accounting period. However a large company, that is one which pays
corporation tax at the standard rate, must pay corporation tax in instalments. These instal-
ments are based on the company’s own estimates of its corporation tax liability for the
accounting year and, for a twelve-month accounting period, there are four equal annual
instalments due on the 14th day of the seventh, tenth, thirteenth and sixteenth month after
the start of the accounting year. So, for an accounting year ended 31 December 20X1, the
corporation tax for the year would be due in four equal instalments payable on 14 July
20X1, 14 October 20X1, 14 January 20X2 and 14 April 20X2.
Although the system imposes upon companies the problem of estimating their taxable
profits as the year proceeds in order to calculate the instalments payable, accounting for the
resulting payments and liability for corporation tax is very straightforward. At the end of an
accounting year, the liability will be the corporation tax payable for the full year less the two
instalments which have been paid during the year.
Tax credits
When a UK company receives a dividend from a UK resident company or pays a dividend to
its shareholders, that dividend carries a tax credit, presently at the rate of one-ninth of the
amount received or paid. This reflects the fact that the dividend comes from income which
has been subject to corporation tax, although there is no direct relationship between the rate

of tax credit and the underlying corporation tax. To a company receiving a dividend with an
associated tax credit, the tax credit has no value. However, individual shareholders receiving
such a dividend would include the gross amount, that is dividend plus tax credit, as part of
their income and then deduct the tax credit from the income tax payable for the year subject
2
This is the rate for the financial year 2002, the year from 1 April 2002 to 31 March 2003. There is also a starting
rate of 10% as well as a small companies rate of 20%.
340 Part 2 · Financial reporting in practice
to the proviso that an individual with a low taxable income cannot claim repayment of the
tax credit. Thus an individual is able to obtain credit for the tax credit but not its repayment.
Withholding tax
Where a company receives interest from or pays interest to another company or individual,
the position is somewhat different. Since the Finance Act 2001, UK companies have been
able to pay interest and royalties gross to other UK companies.
3
However, in most other
cases, the paying company must deduct income tax, presently at a rate of 20 per cent, from
the gross interest and pay this tax over to the Inland Revenue on a quarterly basis. Such a tax
is described as a withholding tax, a tax paid to the Inland Revenue by a company on behalf
of the recipient, and is found in various forms around the world.
Overseas taxation
A company resident in the UK is liable to corporation tax on all its profits whether they arise
in the UK or overseas. As profits which have arisen overseas are usually subject to taxation in
the relevant overseas country, they may therefore be subject to double taxation. Similarly,
where a UK company receives dividends from the taxed profits of an overseas subsidiary,
such dividends are subject to UK corporation tax.
It is usually possible to obtain relief for such double taxation, although the precise nature
of the relief depends upon the terms of any double taxation convention between the UK gov-
ernment and the relevant overseas government. Where there is no double tax convention, it
is still possible to obtain unilateral relief for double taxation.

In some cases it is possible to obtain relief against UK corporation tax for the whole of the
overseas taxation payable but, in other cases, some of the overseas taxation may be unre-
lieved. One example of the latter is where the rate of overseas taxation on overseas profits
exceeds the rate of UK corporation tax on those same profits. To illustrate, let us suppose
that a UK company has taxable profits of £300 000 overseas and an additional £2 000 000 in
the UK. The rate of overseas corporation tax is 50 per cent while the rate of UK corporation
tax is 30 per cent.
The corporation tax payable overseas is 50 per cent of £300 000, that is £150 000, while the
corporation tax payable in the UK is 30 per cent of £(2 000 000 + 300 000), that is
£690 000. As the UK corporation tax payable on overseas income is only £90 000 (30 per cent of
£300000), this is the maximum relief which may be given against the overseas taxation of £150000.
The taxation charge in the profit and loss account would therefore include the following:
£000
Corporation tax on income – 30% of £2 300000 690
less Relief for overseas taxation 90
––––
600
Overseas taxation 150
––––
750
––––
––––
With this background, let us now turn to the provisions of FRS 16.
3
Finance Act 2001, s. 85.
Chapter 12 · Taxation: current and deferred 341
FRS 16 Current Tax
FRS 16 Current Tax, issued in December 1999, is a very short document which is concerned
mainly with the way in which dividends and interest received and paid should be treated in
the profit and loss account of a company when tax credits and withholding taxes are involved.

Paragraph 2 of the standard provides a number of definitions including the following:
Tax credit
The tax credit given under UK tax legislation to the recipient of a dividend from a UK
company.
The credit is given to acknowledge that the income out of which the dividend has
been paid has already been charged to tax, rather than because any withholding tax has
been deducted at source. The tax credit may discharge or reduce the recipient’s liability to
tax on the dividend. Non-taxpayers may or may not be able to recover the tax credit.
Withholding tax
Tax on dividends or other income that is deducted by the payer of the income and paid to
the tax authorities wholly on behalf of the recipient.
As we have seen above, an example of the former is the tax credit attributable to a dividend
received from a UK company. Examples of the latter are income tax deducted at source from
patent royalties or interest received from a UK company or foreign tax deducted at source
from interest or dividends received from an overseas company.
The main purpose of FRS 16 was to lay down standard practice for the treatment of tax
credits and withholding taxes; to be more specific, to rule on whether a relevant income or
expense should be shown at the net amount or at a gross amount including the relevant tax.
In the latter case, the relevant tax would have to appear as part of the tax charge in the finan-
cial statements. This is essentially a pragmatic question and the outcome favoured by a
majority of the Board, as reflected in FRS 16, is to require the grossing up of actual receipts
and payments for any withholding tax but to use the net approach for tax credits.
4
The standard also stresses the need for consistency in where the taxation consequences of
any gain or loss is reported. Thus, where a gain or loss is recognised in the profit and loss
account, then the taxation charge or credit should be reported there as well. Where, how-
ever, a gain or loss is recognised in the statement of total recognised gains and losses, then
the taxation charge or credit should be recognised in that statement too. An example of the
latter would be the taxation consequences of an exchange gain or loss on foreign currency
borrowing which hedge an equity investment in an overseas company.

It requires that the current tax expense in the profit and loss account and in the statement
of total recognised gains and losses should be analysed into UK tax and foreign tax respec-
tively and that each should be analysed to show tax estimated for the current period and any
adjustments related to prior periods. Appendix I to the standard provides a possible, but
non-mandatory, layout of a note to support the current tax charge shown in a profit and loss
account and an example of this is provided in Table 12.1.
Finally FRS 16 provides guidance on what rate of tax should be used to calculate the cor-
poration tax liability for a period:
Current tax should be measured at the amounts expected to be paid (or recovered) using the
tax rates and laws that have been enacted or substantively enacted by the balance sheet date.
(Para. 14)
4
For the arguments considered in reaching this conclusion, see FRS 16, Appendix V, ‘The development of the FRS’,
Paras 9 to 20.
342 Part 2 · Financial reporting in practice
A UK tax rate can be regarded as having been substantively enacted if it is included in either:
(a) a Bill that has been passed by the House of Commons and is awaiting only passage
through the House of Lords and Royal Assent; or
(b) a resolution having statutory effect that has been passed under the Provisional Collection
of Taxes Act 1968. (Para. 15).
FRS 16 is an extremely short standard which provides sensible and uncontroversial solutions
to the question of accounting for current tax.
IAS 12 Income Taxes
IAS 12 Income Taxes, revised in 2000, covers both current tax and deferred tax. With regard to
current tax, there are only relatively minor differences between the requirements of FRS 16
and those of IAS 12. For example, unlike FRS 16, IAS 12 has nothing to say on the tax treat-
ment of dividends receivable and payable. Nor does it mention the recognition of current tax
in a statement of total recognised gains and losses, which is not surprising given that most
countries do not have a requirement for companies to publish such a statement. Instead, it
requires current tax to be charged or credited directly to reserves if it relates to gains or losses,

which have been credited or charged directly to equity. The international standard requires
the separate disclosure of the current tax liability on the face of the balance sheet, while dis-
closure of this may be relegated to a note under UK law, and also requires the disclosure of
any current tax expense relating to discontinued operations, on which FRS 16 is silent.
While the differences between FRS 16 and IAS 12 appear to be relatively minor, they
could lead to considerable differences in reported profit in particular cases, especially where
a company has a large amount of dividend income. As we shall see in a moment, when it
comes to accounting for deferred taxation, the differences between FRS 19 and IAS 12 are
much more important.
Table 12.1 Example of possible note disclosure relating to the current tax charge
shown in a profit and loss account
£000 £000
UK corporation tax
Current tax on income for the period 1200
Adjustments in respect of prior periods 150
–––––
1350
Double taxation relief 220
––––
1130
Foreign tax
Current tax on income for the period 300
Adjustments in respect of prior periods (10)
––––
290
–––––
Tax on profit on ordinary activities 1420
–––––
–––––
Chapter 12 · Taxation: current and deferred 343

Deferred taxation
Timing differences
Although accounting profits form the basis for the computation of taxable profits in the UK,
for most companies there are substantial differences between the two. Such differences may
be divided into two categories: permanent differences and timing differences.
In the case of permanent differences, certain items of revenue or expense properly taken
into account in arriving at accounting profit are not included when arriving at taxable profit.
Examples are regional development grants received, amounts spent on entertainment and
depreciation of non-industrial buildings.
In the case of timing differences, the same total amount is added or subtracted in arriving
at both accounting profits and taxable profits over a period of years, but it is added or sub-
tracted in different periods. It is the existence of such timing differences which gives rise to
the perceived need to account for deferred taxation.
Although there are fewer differences than formerly, because revenue law has now accepted
standard accounting practice for the purposes of taxation in a number of areas,
5
there are still
a number of differences between accounting practice and taxation law which give rise to
timing differences. The more important are:
(a) differences which result from the use of the receipts and payments basis in taxation com-
putations and the accruals basis in financial statements; these differences often reverse in
the subsequent accounting period although they may not always do so. An example of a
timing difference which does not usually reverse in the next accounting period is pension
contributions payable allowed for tax purposes that differ from the pension cost deter-
mined in accordance with the provisions of FRS 17 Retirement Benefits;
(b) availability of capital allowances in taxation computations which are different from the
related depreciation charges in financial statements;
(c) interest or development costs capitalised in the financial statements but allowed as an
expense for tax purposes when paid;
(d) unrealised revaluation surpluses on fixed assets, recognised in the statement of total

recognised gains and losses, for which a taxation charge does not arise until the gain is
realised on disposal of the asset;
(e) realised surpluses on the disposal of fixed assets, recognised in a profit and loss account,
which are subject to rollover relief for taxation purposes;
(f) tax losses carried forward to be used against taxable profits which arise in the future;
(g) unrealised profits from inter-group trading which are removed in the consolidated
financial statements;
(h) unremitted profits of subsidiaries, associates and joint ventures recognised in consoli-
dated financial statements but not taxable until remitted.
6
One of the four fundamental accounting concepts listed in company law is the ‘accruals’
concept, under which expenses are matched against the revenues recognised in a particular
accounting year. While some accountants might argue that taxation is an appropriation of
5
Interested readers are referred to Graeme Macdonald, The taxation of business income: Aligning taxable income
with accounting income, The Tax Law Review Committee, The Institute for Fiscal Studies, London, April 2002.
6
Fair value adjustments applied in a business combination treated as an acquisition are often treated as timing dif-
ferences but we shall not deal with such complexities here. Interested readers are referred to the latest edition of
UK and International GAAP, Ernst & Young, published by Butterworths Tolley, London.